China’s leading power ambitions and the gold reserve mystery
The People’s Bank of China on July 17 disclosed its gold reserves for the first time since 2009. Its holdings of the metal rose to 1,658 tonnes from 1,054 tonnes six years ago, an increase of close to 60 per cent, writes Prince Michael of Liechtenstein.
Some believe that this disclosure is part of a Chinese effort to add the yuan to the International Monetary Fund’s basket of world reserve currencies, called Special Drawing Rights, alongside the US dollar, the euro, the Japanese yen and the British pound. A reserve currency is a currency other central banks invest their assets in.
China now officially holds the world’s sixth largest gold reserve after the United States (8,133 tonnes), Germany (3,384 tonnes), the IMF, France and Italy. Russia, whose central bank is also increasing its gold reserves and has tripled its holdings since 2005, was pushed back to the seventh rank.
The reliability of China's declared figure for its gold holdings can be questioned. Another issue is why Russia and, especially, China are building up their gold reserves so strongly.
Bloomberg Intelligence, in a report on April 20, 2015, estimated China’s actual gold reserve at 3,510 tonnes, based on foreign trade data, domestic output and figures from the China Gold Association. This is more than double the amount disclosed by the central bank and would push China’s holdings to the second largest, after the US.
It could be that these reserves are not being held directly by the central bank, but by other government agencies such as the State Administration of Foreign Exchange and the China Investment Corporation. In this context, we should mention that China is the world's largest gold producer.
For the two decades leading up to the collapse of Lehman Brothers in 2008, central banks around the world continually reduced their gold reserves, assuming that gold was not needed in the monetary system. The Bank of England sold 395 tonnes at low prices from 1999 through 2002, while the Swiss National Bank sold 1,300 tonnes through 2005. After 2008, central banks began buying gold again, especially those in emerging market countries.
More than 60 per cent of global foreign currency reserves are held in US dollars, followed by the euro. Confidence in the US Federal Reserve and the European Central Bank has eroded after the institutions adopted policies of quantitative easing. Perhaps China and Russia intend to diversify from dollar and euro paper money to alternatives that are more sustainable and hold value.
China’s currency reserves, equivalent to almost US$4 trillion, are the world’s largest due to a continuous trade surplus. Most of these reserves are held in US dollars, with some invested in the euro capital markets. At present prices, officially declared gold represents less than 2 per cent of China’s reserves – a nearly negligible diversification.
If China is building up its gold reserves, why is this not being fully disclosed? Increased holdings of the metal might even facilitate the yuan’s inclusion in the IMF’s basket of reserve currencies.
One answer is the technical difficulties China faces in diversifying from inflated US dollar and euro-denominated paper assets. The European and US debt markets are highly dependent on Chinese inflows; consequently, any significant diversification by China to other asset classes would put bond prices and Western economies under pressure.
China may indeed want stronger gold backing in order to increase trust in the yuan as a reserve currency, anticipating that confidence in the dollar and euro will continue to erode as quantitative easing keeps interest rates close to zero.
A potential negative interest rate policy in the eurozone, combined with discussions about abolishing cash altogether, does even more to destroy trust in the traditional leading currencies.
China needs a strong position in the monetary system in order to consolidate its role as a leading world power. A strong yuan, together with steps such as the creation of the Asian Infrastructure Investment Bank, could establish China as a serious, trusted player in the global monetary system.
China has nothing to gain from more transparency. Obscuring its true intentions gives the country more flexibility in future decisions and market moves, depending on how gold, the US dollar and the euro fare.